Germany's controlled foreign corporation rules (CFC rules, Hinzurechnungsbesteuerung) date back to 1974 and have never really been modernized. Low taxed income, for instance, is understood as income subject to a corporate income tax rate of 25%. In the meantime, however, Germany, has reduced its corporate income tax rate to 15%.  Even if you take into account German trade taxes, situations exist where, depending on the local trade tax multiplier, Germany itself qualifies as a low-taxed jurisdiction.

The minimum standards for CFC rules set out in ATAD1 must now be incorporated into national law. Governmental representatives officially hold the view that Germany is already over-achieving these minimum standards (honi soit qui mal y pense).

Nevertheless, draft legislation has recently leaked which suggests a more substantial reform of the German CFC rules:

• Good news first: In order to qualify as a CFC  the foreign corporation must now be controlled by one German shareholder (including related persons and persons acting in concert) and not just by Germans (irrespective of whether or not they are related).
• Capital investment-type income will still not require a controlling stake (portfolio participations of 1% or even below remain sufficient).
• Activities must continue to qualify as active (anything else is in the bad passive basket). The definition will be modernized in some aspects (for example, on where shareholder participation is deemed harmful) but also be significantly tightened for group-internal procurement/distribution subsidiaries, for R&D/shared-services centres and for dividends (portfolio dividends and dividends deducted at the level of the CFC will become passive).
• The no-abuse/substance test (Cadbury Schweppes) will be amended.
• Passive low-taxed income of lower-tier subsidiaries will be attributed directly to the controlling shareholder - which is technically simpler but might result in separating profits of one CFC from losses of another CFC.
• Last but certainly not least: The proposed threshold for low-taxation will remain – at least for now (it is square-bracketed in the unofficial draft) – at 25%.

For most groups, the practical implications will mainly depend on the definition of active/passive activities and on how high (or low) the bar for low taxation is finally set. Surveys suggest that the current proposal could make 80% of foreign distribution subsidiaries of German-headquartered multinationals CFCs. In times of reducing corporate tax rates this number is likely to rise. The consequence is not 'just' the extra tax cost but also the massive compliance obligations.

Governmental representatives confirm that neither the definition of active activities nor the 25% rate are carved in stone yet. Hopefully, the German legislator will now reflect on how this package could put German-headquartered multinationals at a competitive disadvantage.